The Lynch Bull investment company suggeststhat Steven

Chapter , Problem 12-16

(choose chapter or problem)

The Lynch Bull investment company suggeststhat Steven Comstock, a wealthy New York Cityinvestor (his incremental income tax rate is 35%),consider the following investment.Buy corporate bonds on the New York StockExchange with a face value (par value) of $100,000and a 5% interest rate paid annually. These bondscan be purchased at their present market value of$75,000. Each year Steve will receive the $5000interest, and after 5 years, when the bonds mature,he will receive $100,000 plus the last $5000 ofinterest.Steve will pay for the bonds by borrowing$50,000 at 10% interest for 5 years. The $5000interest paid on the loan each year will equal the$5000of interest income from the bonds.As a resultSteve will have no net taxable income during thefive years due to this bond purchase and borrowingmoney scheme.At the end of 5 years, Steve will receive$100,000 plus $5000 interest from the bonds andwill repay the $50,000 loan and pay the last $5000interest. The net result is that he will have a $25,000capital gain; that is, he will receive $100,000from a $75,000 investment. (Note:This situationrepresentsan actualrecommendationof a brokeragefirm.)(a)Compute Steves after-tax rate of returnon this dual bond-plus-loan investmentpackage.(b)What would be Steves after-tax rate of returnif he purchased the bonds for $75,000 cash anddid notborrow the $50,000?